Currency Observations From A 'European Vacation'

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Includes: HEWG, HEZU
by: Heidi Richardson

Heidi Richardson recently visited 10 European countries over four weeks, and observed many signs supporting a currency-hedged exposure to European stocks.

I just returned from what I like to refer to as my version of the Griswolds' "European Vacation": I visited 10 countries in Europe over four weeks, spending the last two weeks on a road-trip vacation around the region.

Much of what I observed during my trip reinforces that now may be a good time to consider raising allocations to eurozone equities.

Take my conversations with locals everywhere from Irish pubs to French cafes. Those I talked with didn't seem concerned about a "Grexit" and instead were more worried about local issues like taxi strikes and port closures, reinforcing that Greece's direct impact on Europe and the global economy appears to be small and that the recent Greek drama may not be a reason to avoid investing in the region. Meanwhile, there was evidence everywhere that the European Central Bank's (ECB) monetary stimulus appears to be spurring economic growth, from the packed restaurants to the crowded shops.

But what really struck me were the many signs of just how important it is to consider the possible impact a weaker euro could have on U.S. dollar-based European investments. (Remember, for USD-based investors, buying foreign securities is a two-part transaction involving the return of the security and the return of the currency.)

The view from Königssee Lake, Germany

The view from Königssee Lake, Germany

Booming tourism

I was far from the only one on a European adventure. Since January, according to Bloomberg data, the euro has weakened roughly 10 percent versus both the dollar and the pound, as central bank policies diverge. From what I could see, many tourists from the U.S. and elsewhere were taking advantage of favorable exchange rates. There were long lines at the Eiffel Tower, Colosseum and even the Königssee Lake. But while a weakening euro is good for airline fares, the European economy and large European exporters, it can potentially hurt the returns of dollar-based investments.

Volatile exchange rates

During my trip, whenever I visited an ATM, I could see firsthand just how volatile exchange rates can be. While I withdrew the same amount consistently, the withdrawal cost me less and less in dollar terms as the euro dropped 2.4 percent over the course of my stay, including a 2 percent drop over four days mid-trip, according to Bloomberg data.

My campsite view in Zell am See, Austria

My campsite view in Zell am See, Austria

Looking forward, currency volatility is only likely to continue, as the Federal Reserve (Fed) and ECB's monetary policies diverge further and the dollar potentially appreciates vs. the euro. As currency volatility can have a significant impact on the total return of an international investment, thinking about how to potentially insulate a portfolio from such currency ups and downs is more important than ever.

So, while the case for adding exposure to European stocks remains strong, especially with a weakening euro serving as a tailwind for the European economy and European firms, investors seeking to capitalize on this opportunity must contend with fluctuating exchange rates. Exchange traded funds, such as the iShares Currency Hedged MSCI EMU ETF (NYSEARCA:HEZU) and the iShares Currency Hedged MSCI Germany ETF (NYSEARCA:HEWG), can provide access to the eurozone market and Germany, respectively, while potentially mitigating exposure to fluctuations between the value of the euro and the U.S. dollar.

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